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Failure of creditor class to cast vote on chapter 11 plan does not equate to acceptance

The solicitation of creditor votes on a plan is a crucial part of the chapter 11 process. At a minimum, a chapter 11 plan can be confirmed only if at least one class of impaired creditors (or interest holders) votes to accept the plan. A plan proponent’s efforts to solicit an adequate number of plan acceptances, however, may be complicated if creditors or other enfranchised stakeholders neglect (or choose not) to vote. The Bankruptcy Code does not provide a mechanism to force creditors to vote, nor does it clearly spell out the consequences of not voting where none of the creditors or interest holders in a given class have voted to accept or reject a chapter 11 plan. The lack of any clear guidance on this important issue has spawned a rift in the courts. In In re Vita Corp., an Illinois district court recently addressed the ramifications of a creditor class’s failure to vote in its entirety, ruling that classes in which all impaired creditors fail to cast ballots either accepting or rejecting a plan are not deemed to have accepted the plan for purposes of confirmation.

Chapter 11 Voting and Confirmation Rules

Chapter 11 plan confirmation is governed by Bankruptcy Code section 1129, which provides for both consensual and nonconsensual confirmation. The rules governing consensual confirmation, which are set forth in section 1129(a), include the requirement that “with respect to each class of claims or interests (A) such class has accepted the plan; or (B) such class is not impaired under the plan.” Another requirement is that “[i]f a class of claims is impaired under the plan, at least one class of claims that is impaired under the plan has accepted the plan, determined without including any acceptance of the plan by any insider.”

In the absence of nonimpairment or approval by each impaired class, confirmation is possible only under chapter 11’s “cram-down” standards, which are contained in section 1129(b). The rules governing nonconsensual confirmation similarly include the requirement that at least one impaired class must vote to accept the plan.

Bankruptcy Code section 1126 spells out the chapter 11 voting requirements. Under this provision, a class of claims has accepted a plan if the plan has been accepted by creditors “that hold at least two-thirds in amount and more than one-half in number of the allowed claims of such class held by creditors . . . that have accepted or rejected such plan.” A class of interests accepts a plan if the plan has been accepted by interest holders “that hold at least two-thirds in amount of the allowed interests of such class held by holders of such interests . . . that have accepted or rejected such plan.” A class that is unimpaired by a plan is deemed to accept it. Any class whose members are to receive nothing under a plan is deemed to reject the plan.

As noted, the statute does not specify what happens if all the creditors or interest holders in a class entitled to vote fail to do so for whatever reason. The failure of enfranchised stakeholders to cast a vote can pose a significant problem, especially if the chapter 11 plan provides for treatment of one or more classes that contain only a single creditor or a handful of creditors, such that one creditor’s failure to cast a vote means that the statutory acceptance majorities cannot be attained.

This section requires a plan to be actively accepted. If a creditor does not cast a ballot, the amount owed to that creditor, and the creditor as a member of the class, is not included in the computation of whether the class accepted the plan. The Senate Committee comment to this section makes this clear, “[t]he amount and number are computed on the basis of claims actually voted for or against the plan, not as under chapter X [formerly section 501 et seq. of this title] on the basis of the allowed claims in the class.”

Notwithstanding what would appear to be a clear indication that the failure to vote should not be counted as an acceptance or rejection, this issue continues to generate confusion in the courts. Some courts, including the Tenth Circuit Court of Appeals, have held that a nonvoting class is deemed to have accepted a plan. In In re Ruti-Sweetwater, Inc., the Tenth Circuit reasoned that refusing to deem the failure of an impaired class to vote to be acceptance of the plan “would be to endorse the proposition that a creditor may sit idly by, not participate in any manner in the formulation and adoption of a plan in reorganization and thereafter, subsequent to the adoption of the plan, raise a challenge to the plan for the first time.” According to the court of appeals, such an approach “would effectively place all reorganization plans at risk in terms of reliance and finality.” Other courts, representing the majority position, have ruled that a nonvoting class is not deemed to have accepted a plan. An Illinois district court recently weighed in on this controversial issue in Vita Corporation.

Vita Corporation

Vita Corporation operates an Old Chicago restaurant franchise in Peoria, Illinois. Vita filed for chapter 11 protection in 2006 in Illinois. Its proposed plan of reorganization created nine classes of creditors, six of which were impaired. Three classes cast ballots in sufficient majorities to accept the plan, but the creditors in the other three classes did not cast votes to accept or reject the plan. Because Vita did not receive any ballots rejecting the plan, it sought confirmation of the plan under section 1129(a).

At the confirmation hearing, the bankruptcy court questioned whether the failure of the three classes to vote should be considered acceptance of the plan by those classes. Acknowledging the existence of a split of authority on the question and the lack of any binding precedent in the Seventh Circuit, the court denied confirmation of the plan, ruling that “[s]ections 1129(a)(8) and 1126(c) require the affirmative assent of a creditor as the necessary means by which that creditor accepts a plan” and that “[a] creditor’s failure to return a ballot rejecting the plan, does not constitute the creditor’s deemed acceptance of the plan.” Vita appealed.

The District Court’s Decision

The district court affirmed the ruling. Noting that the Seventh Circuit has not yet addressed the question, the district court agreed with the bankruptcy court’s conclusion that section 1126 “plainly” requires each creditor to affirmatively accept the plan in order to constitute acceptance. In addition, the district court explained, Bankruptcy Rule 3018(c) provides that “[a]n acceptance or rejection shall be in writing . . . [and] be signed by the creditor or equity security holder or an authorized agent.” The rule’s express requirement of a written ballot accepting a plan, the court emphasized, stands in stark contrast to other provisions of the Bankruptcy Code that allow a failure to act to be deemed an acceptance, such as section 1126(f), which specifically deem an unimpaired class to have accepted without voting.

The court rejected the contrary approach advocated by the Tenth Circuit in Ruti-Sweetwater, characterizing the decision as “result-oriented” and contrary to the dictates of the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure. According to the court, the Bankruptcy Code specifically provides for an alternative means of obtaining confirmation if a class of impaired creditors does not cast a ballot—section 1129(b)’s cram-down provisions. This alternative, the court emphasized, would appear to be superfluous if courts were to presume that nonvoting impaired class members had accepted a proposed plan. By ignoring “precise requirements” established by the statute and the rules implementing it, the district court cautioned, a court becomes a legislative body and impermissibly implements policy.

Conclusion

Vita Corporation widens the split of authority on the question of whether an impaired class whose creditors fail to vote is deemed to have accepted a chapter 11 plan for purposes of confirmation. From the perspective of plan proponents, the ruling underscores the importance of maintaining active lines of communication with key creditor constituencies during a chapter 11 case (particularly during the vote-solicitation period) to ensure that the proponent can muster an adequate number of acceptances in the form of timely submitted ballots to obtain confirmation of a plan, either consensually or otherwise. Plan proponents may be unable to rely on inaction as a surrogate for affirmative acceptance.

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